Could Cyprus Bring Down the Euro?

The idea that little Cyprus – population 1.1 million; that’s fewer than Dallas, Texas – could fracture the euro zone sounds ridiculous, and probably is, but it’s not impossible and it’s something that’s being talked about.

The argument was summed up earlier this week by Marc Chandler, the well respected global head of currency strategy at Brown Brothers Harriman in New York. In a research note headlined ‘Why Cyprus is Important,’ he wrote that Cyprus may be the most pressing issue for the euro zone. “Yes it is small and few international investors have any exposure. However, its significance extends beyond its size,” he said.

Mr. Chandler then outlined four main issues: the amount of assistance Cyprus needs is still not determined. Reports in the German media at the end of last year warned that Cypriot banks have been used to avoid taxes and launder, primarily Russian, money. Fissures are evident between the European Union, the European Central Bank and the International Monetary Fund on how to deal with Cyprus. And, finally, the EU has been accused of playing political favorites in its dealings with Cyprus.

This is how Mr. Chandler summarized his paper: “While last year we argued against the widespread view of a Greek exit, we are not as sanguine about Cyprus… We suspect the risks of a Cyprus exit are greater than currently appreciated.”

Nervousness about Cyprus was increased this week by an article in Germany’s Der Spiegel reporting that the urgently-needed bailout of the Cypriot banking industry is in danger of being vetoed by the German parliament. This increased further when Moody’s Investors Service Thursday cut its rating of Cyprus three notches, saying a growing burden of bad debts for the country’s banking sector has pushed the likelihood of default to 50%.

This is how our own Berlin reporters summarized the problem: “German political leaders are increasingly expressing reservations about providing bailout aid for Cyprus’s ailing banks, calling into question whether the German parliament would vote to approve an aid package for the financially troubled nation,” they reported.

So what’s the view from Cyprus itself? “I think the numbers are so small relative to what the EU has committed elsewhere that I doubt they would endanger the entire euro edifice over this tiny nation,” said Marshall Gittler, head of global foreign exchange strategy at IronFX, who is based in Limassol.

If Cyprus works out a method to extricate itself and reinstate its previous currency, that would establish a precedent, and the risk of other countries using that template would escalate dramatically, Mr Gittler said. “It would be the Lehman Bros. of the euro zone; not that significant for the markets by itself but a game-changer for what it means for official policy in the future.

Having committed hundreds of billions to backstop the other euro-zone nations, I can’t imagine they would begrudge Cyprus a sum an order of magnitude less to put it on a sound footing. The risk/reward balance is overwhelmingly in favor of supplying the money sooner or later,” said Mr. Gittler.

And that’s almost certainly true. Germany and the other richer euro-zone nations will in all likelihood provide the money in the end as the principle that it’s impossible to leave the euro zone, having joined, will be deemed more important than spending a few billion euros more. But German approval will not be easy to reach.

“As things currently stand, I can’t imagine German taxpayers bailing out Cypriot banks, whose business model depends on abetting tax fraud,” Sigmar Gabriel, chairman of the opposition Social Democrats, told the Süddeutsche Zeitung in an article published earlier this week. If German Chancellor Angela Merkel “wants SPD support for a Cyprus aid package, she will have to have excellent arguments. At the moment, however, I don’t see what those might be.”

*Update: the 1.1 million population figure is a July 2012 estimate from the CIA World Factbook.

Comments (5 of 5)

When you can't even get the population size right .... what's more to say about the rest of the analysis

7:26 am January 11, 2013

Jamez wrote :

Dont you guys have anything better to write? Seriously? In the past it was "Greece to bring down the euro", not to mention the combined effect of Portugal Ireland Greece and Spain. When none of that achieved the euro's downfall, you now go on about Cyprus??
Seriously???

6:59 am January 11, 2013

@6:43 wrote :

Europe has not "weathered the PIIGS crisis" anymore than the "fiscal cliff" deal has the US "weathering" our debt problems. They did manage to bail out Greece temporarily, and they managed to get Spain's problems from the front-burner to the back. Impressive, but very short-lived. There will be more Euro debt crises in 2013, likely Spain first. Watch out for France, if not this year then soon after.

6:43 am January 11, 2013

Anonymous wrote :

now that Europe had weathered the "PIGS" financial crisis - we are starting a new one -

same story here - Germany trying to get other countries to be responsible for their finances -

maybe we should contact them about the financial mess of the United States

6:40 am January 11, 2013

Shiloh wrote :

If the Cypriots reinstate their currency, it means two things:

1) Cypriot politicians are more accountable to their people than Greek politicians are to theirs

2) Cypress is unwilling to allow their country to be stolen out from under them, like the Greeks

This is Germany doing economically what it twice, previously failed to do militarily...